Raise the Hammer

Here We Go: Russia Challenges Petrodollar Hegemony

According to yesterday's Telegraph, Alexei Kudrin, the Russian finance minister, challenged petrodollar hegemony during the annual meetings of the World Bank and the International Monetary Fund (IMF).

The article reports:

The greenback's recent volatility and the yawning US trade deficit, "are definitely causing concern with regard to its reserve currency status," he said. "The international community can hardly be satisfied with this instability."

At the same time, the G7 (which does not include Russia) is debating how to address inflation triggered by rising oil prices. As Andrew McKillop observes in his recent RTH essay, the monetarists running our finance departments and central banks are responding by raising interest rates.

The author reminds us, "The US Federal Reserve, in particular, has been forced to take drastic action - raising interest rates 15 times since June 2004 to keep inflation in check."

Russia senses an opportunity to shift power away from America, which is struggling with an historically high government deficit and debt (the highest since WWII) and a massive current accounts deficit.

Today, US dollars and treasury securities make up over two thirds of global reserve holdings, mainly because governments needs US dollars to buy oil. As the price of oil has tripled in the past half-decade, the global demand for US dollars has only escalated, allowing America to import over $700 billion more than it exported last year.

This situation is tenable only as long as the world continues to use dollars to buy oil. According to the report, "The unprecedented weight of US liabilities means a threat to the dollar's dominance could result in a currency collapse, plunging the world's largest economy into recession."

Central banks are already starting to reduce their exposure to US currency. Sweden, for example, recently cut its dollar holdings from 37 percent of its reserves to 20 percent, increasing its holdings of euros.

Russia, a major global player in oil and natural gas production, is positioning itself to take advantage of America's vulnerability. Part of that strategy will surely be to introduce the euro as an alternate petroleum trading medium.

Europe is Russia's biggest customer, and its economy is similar in scale to America's. The difference is that Europe's economic fundamentals are sound.

Kudrin's announcement is an opening salvo in a struggle to shift the centre of the world's political economy away from the US and toward Eurasia, which has most of the world's people and most of the world's remaining resources.

RTH has written before about Iran's plan to introduce a petroleum exchange denominated in euros. Iran's plan to launch it in March has been delayed until later in the year, and as American anti-Iranian rhetoric continues to ratchet up, the pressure on Iran to abandon its plan altogether continues to rise.

Russia is now applying pressure in the opposite direction. As the Telegraph notes:

It is worth noting that Tehran has ongoing plans to set up an oil trading exchange to compete with New York's NYMEX and with London's International Petroleum Exchange. In the light of Kudrin's comments, it is significant that the Iranians want to run their oil bourse in euros, not dollars.

Were the Iranians to establish a Middle-East based euro-only oil exchange, the dollar's unique petrocurrency status could unravel. That, in turn, would threaten its broader dominance - which, given America's groaning twin deficit, could seriously hurt the US economy.

The author stops short of arguing that the oil bourse is "the real reason the US wants to atack Iran", but notes that the plan "is certainly an aggravating factor".

The author concludes that "the US currency will retain its hegemony" only to the extent that it retains its privileged position as the medium of exchange for OPEC oil. Kudrin has broken the seal on a growing sentiment among other countries that the best way to preserve a stable global economy is to reduce global exposure to an unstable dollar.

Kudrin's missive comes as central bankers, and currency dealers, start to conclude the only way to resolve the massive US external deficit is a somewhat weaker US currency. As the IMF itself warned yesterday, a "substantial" dollar decline may be needed.

An idea that has drifted around the margins of international discussion is finally out in the open. America has to decide whether it wants to work with the rest of the world to distribute economic power more evenly between the dollar and the euro, or whether it wants to squander the last of its hegemonic power on a desperate, and ultimately futile, gambit to remain in control.

Ryan McGreal, the editor of Raise the Hammer, lives in Hamilton with his family and works as a programmer, writer and consultant. Ryan volunteers with Hamilton Light Rail, a citizen group dedicated to bringing light rail transit to Hamilton. Ryan writes a city affairs column in Hamilton Magazine, and several of his articles have been published in the Hamilton Spectator. He also maintains a personal website, has been known to share passing thoughts on Twitter and Facebook, and posts the occasional cat photo on Instagram.